June 07 , 2012
An arbitrage fund is a mutual fund that tries to take advantage of instance mis-pricing in the market. For instance, a variance in pricing between the stock price and its futures price may provide an interesting opportunity for returns. The fund may buy the stock and 'short' the future; or vice versa.
In terms of its risk and return, an arbitrage fund is similar to a debt fund. In fact, it is close to that of a liquid fund. It is independent of stock prices and the value of the index - thus it is very different from an equity mutual fund. You can think of this as an alternative to keeping money in the bank account or in fixed deposits. Generally, an arbitrage fund does well when market trading volumes are high.
An arbitrage fund is treated as an equity mutual fund from the point of view of taxation. Thus, it benefits from a more lenient tax regime compared to debt mutual funds.